Understanding Second MortgagesWhen you find yourself in need of financing for a home improvement project, or an unexpected expense, a second mortgage could be a viable option to consider. A second mortgage is a loan that is secured by your home, using the property as collateral in the event that you default on the loan. Second mortgages are typically much smaller than the primary mortgage on your home and can be obtained in two forms: Home Equity Loans and Home Equity Lines of Credit (HELOC).
Differences between First and Second MortgagesThe main difference between a first and second mortgage is the order in which they are placed on the property. The first mortgage is the primary loan on the home and is usually the largest in amount. The second mortgage comes second in order, and if there is a default on the loan, the lender of the primary mortgage is paid first out of the proceeds of the sale, with the second mortgage being repaid afterwards.
Home Equity Loans ExplainedA home equity loan is a fixed-rate loan that is secured by the equity in your home. Equity is the difference between the current value of your home and the outstanding balance of your first mortgage. Home equity loans usually come in a lump sum and can be used for any purpose, such as debt consolidation, home improvement projects or college tuition. The interest rate on a home equity loan is usually lower than an unsecured loan such as a credit card. Home equity loans typically have fixed interest rates, which means the monthly payment amount remains the same throughout the life of the loan.
HELOC ExplainedA HELOC is a variable rate loan that allows you to access the equity in your home as needed. Similar to a credit card, a HELOC provides a line of credit based on the amount of equity in your home. The interest rate on a HELOC is usually lower than an unsecured loan and only accrues when you use the funds. It is important to note that the interest rate on a HELOC can fluctuate, which means your monthly payment amount can vary as well. Key Point: A HELOC is a variable rate loan that provides a line of credit based on the amount of equity in your home, with the interest rate usually lower than unsecured loans.
Benefits of Second MortgagesThere are several benefits to obtaining a second mortgage, including:
- Ability to access home equity as needed
- Lower interest rates compared to unsecured loans
- Possible tax benefits on the interest paid
- Flexibility on how funds are used
Potential Drawbacks of Second MortgagesWhile second mortgages can provide helpful financing options, there are also potential drawbacks to consider, including:
- Increased debt and interest payments
- High fees and closing costs
- Risk of losing your home if you default on payments